Following Thames Water’s announcement of Bazalgette Tunnel Limited as the preferred bidder for the Infrastructure Provider to deliver the Thames Tideway Tunnel Project on 14 July, Ofwat has launched a new consultation prior to granting a project licence and issuing a waiver notice.

Ofwat is now seeking comment on a range of issues, including whether the preferred bidder is fit and proper to hold a project licence – the consultation document sets out why Ofwat considers Bazalgette Tunnel Ltd is competent to hold the licence.

An Ofwat spokesperson said:

“In summary, it sets out, among other things, how we will regulate the IP, including how the IP's allowed revenues are calculated, and how risks around costs and delivery will be managed and incentivised. The IP needs a licence, as ultimately the revenue it receives will come through sewerage customers' bills.”

 “It proposes that the benefits of outperformance, as well as the risk of overspend, will be shared by customers and the IP, with customers sharing a greater proportion of outperformance than is the case with over spends. This keeps financing costs – and therefore ultimately bills – down, while incentivising the IP to deliver on time and below budget.”

Under the consultation Ofwat is proposing a shared pain/ gain mechanism approach to the financing of the £4.2 billion Tideway Tunnel. Customers could see a financial benefit from any underspend by Bazalgette - Ofwat is proposing a figure of 70% going to customers. However, in the event of an overspend by the Infrastructure Provider, customers would be expected to bear 60% of the extra cost, with Bazalgette contributing 40%.

Final bids submitted on 3rd July - Bazalgette named as preferred bidder on 14 July

Thames Water put the TTT Project out to tender in June 2014 - 12 bidders were pre-qualified and invited to tender during the first round of bidding, with two final bids submitted on 3 July 2015 following a final revise and confirm round. Having evaluated the bids, on 14 July 2015 Thames Water announced that Bazalgette Tunnel Limited had been selected as the preferred bidder for the project. Ofwat and the Secretary of State were consulted on the terms on which the project was put out to tender, including on the terms of the final revise and confirm bidding round.

In a parallel but separate process, both shortlisted bidders applied to Ofwat for a project licence and Ofwat conducted an assessment of both shortlisted bidders in order to determine if both bidders were fit and proper bodies to hold a project licence.

The consultation document says the reason the assessment was carried out before the IP procurement was finalised was so that bidders would be given sufficient notice if there was anything in their applications for a project licence that caused Ofwat concern.

“We wanted to avoid a situation where a bidder was successful in the IP procurement but was considered by us at a later stage not to be an appropriate body to be awarded a project licence,” Ofwat said.

“Both shortlisted bidders were competent to hold project licence”

Following the assessment the regulator concluded that, subject to various caveats, both bidders were competent bodies to hold a project licence. The caveats included:

• receipt and review of the preferred bidder’s final shareholder agreements and financing and associated documentation;
• receipt of undertakings from the preferred bidder’s ultimate controllers and, where required, UK Holding Companies under condition K of the draft project licence; and,
• consideration of any responses to this consultation.

In order to ensure that Bazalgette Tunnel Limited is a competent body to hold a project licence and that the Board of Directors, who will play a key role in managing the delivery of the Project, consists of an appropriate mix of experienced individuals, Ofwat has also reviewed the management structure proposed for the Project.

The consultation document states:

“The proposed composition of the board is in accordance with Ofwat’s published board leadership, transparency and governance principles and the company has committed to comply with these principles in the future and with the holding company governance principles.”…

 “It should be noted that the first four independent non-executive directors and the executive directors have been involved with the Project for over a year and have overseen the procurement of three construction consortia who will be responsible for the construction of the tunnel.”

Bazalgette financing plan provides “robust funding package”

Ofwat said it has reviewed the financing plan prepared by the prospective owners of the IP and consider that it provides a “robust funding package” to enable the successful delivery of the project in compliance with the project licence.

The consultation paper says the prospective owners have stated that the financing plan has also been designed to ensure the IP will be a “strong counterparty” to Thames Water, the Secretary of State as provider of the Government’s support package and to all other counterparties throughout the Project.

Thames Water’s procurement strategy, developed in consultation with Government and Ofwat, provided for a parallel procurement process whereby Thames Water procured, on behalf of the IP, various contracts necessary for the construction of the Tunnel.

The consultation paper says Ofwat agreed to support the parallel procurement of the construction contracts and the IP for timing reasons and that if Thames Water had first procured the IP on the basis that the IP would then procure the construction contracts, it would not have been possible to award the contracts in 2015 in time for work to begin in 2016. “Any delays in commencing construction will increase the likelihood and size of any fines that may be imposed on the UK Government for non-compliance with the Urban Waste Water Treatment Directive,” the paper states.

Specified construction contracts subject to robust competitive process

The consultation also covers Ofwat’s proposal to issue a Waiver Notice meaning the IP will not have to comply with the procurement regime set out in the Utilities Contracts Regulations (UCR) in respect of seven contracts . The contracts are: the three main construction contracts; the system integrator contract; two framework agreements (one in respect of occupational health and one in respect of security); and the contract for the services of an Independent Technical Assessor.

The contracts have all been procured by Thames Water under the UCR but will be entered into by the IP after licence award. Ofwat said:

“We consider that the waiver will provide best value for money for customers, as these contracts have already been subject to a rigorous competition and we consider it is not necessary for the IP to have to procure these contracts afresh after licence award.”

“We consider that issuing a Waiver Notice in respect of these contracts will ensure that the project benefits from continuity, technical expertise, bidder certainty and improved commercial terms, resulting in enhanced customer value for money. “

One of the key changes to the Project Licence is on the timing of the First Periodic Review to take place after the Post Construction Review and Thames Water’s acceptance of the TTT as part of its infrastructure. In the previous draft the First Periodic Review was scheduled to coincide with the first periodic review of Thames’ wholesale activities to occur after the Post Construction Review. This has now been hardwired so that it will occur in 2029, unless acceptance has not occurred by 1 January 2029, in which case it will be postponed until 2034.

The change is necessitated by the decision to ask bidders to bid a cost of capital that will be in place until 1 April 2030.

IP dividend policy should be incentive to reward efficiency and management of economic risk

Among the many provisions contained in the lengthy 137 page detailed and complex draft Project Licence document, which includes the process in the event of the IP going into administration, it states:

“The Infrastructure Provider must, at all times, have in place a dividend policy which effectively embodies:

(a) the principle that dividends declared or paid should not impair the ability of the Infrastructure Provider to finance the Licensed Business; and

(b) the principle that dividends should be an incentive which is expected to reward efficiency and the management of economic risk.”

It also says the Infrastructure Provider must not create any liability in relation to the IP Regulated Assets without  Ofwat’s prior approval.

Ofwat to regulate IP in manner “best calculated to further the consumer objective”

The consultation paper says that Ofwat will regulate the IP in the manner which it considers is “best calculated to further the consumer objective”,  secures that the functions of a water undertaker and of a sewerage undertaker are properly carried out and secures that the IP can finance the proper carrying out of those functions -  in particular, by securing reasonable returns on capital.

Deadline for responses to the consultation is 14 August 2015.

Click here to download the consultation paper

Click here to download the summary of changes to the draft Project Licence

Click here to download the full revised draft Project Licence